Summary. Publicly traded firms are expected to create shareholder value, allocating their scarce resources to the most

Transcription

1 Projects and Shareholder Value in Financial Services PMI NIC, 5 Nov 09 Mauro Tortone, PMP, MSI

2 Summary Publicly traded firms are expected to create shareholder value, allocating their scarce resources to the most promising operations and projects Ten areas critical to the selection and management of projects aimed at maximising shareholder value were identified using the literature available Several weaknesses that financial firms should address to maximise SV thru projects were highlighted in an industry survey, based on the ten critical areas 2

3 Projects Projects and Shareholder Value are a way in which firms take advantage of opportunities and deal with threats are, nowadays, a continuous effort, alongside operational processes represent, arguably, the larger portion of the future earnings of a firm Shareholder Value Business value + marketable securities or investments market value of debt and obligations* Business value is the value generated by the cash flows in which all providers of funds have a claim *Mills et al 3

4 The Questions How aligned are projects to maximising Shareholder Value (SV) in Financial Services? What are the areas in which improvements could be made by financial firms? Theory in the Financial Services sector, the key to maximising SV is achieving the right mix of projects, coupled with effective allocation of resources between operations and projects Objectives: To analyse how financial firms select and manage their project portfolios, in relation to SV To identify the improvement areas (disconnects between projects and creating SV) To offer recommendations on how to address the improvement areas 4

5 Literature Reviewed literature sources The review suggests that, though there is extensive research on company valuation and single projects appraisals, there is limited research that attempts to relate projects and SV The literature available quite clearly indicates that projects have a significant impact on SV The financial services industry is no exception Ten areas and fifty indicators: questionnaire questions 5

6 Questionnaire Group High scores indicate 1. Shareholder Value (SV) drivers a firm manage to maximise the SV / is aware of its main SV drivers (revenue growth, profit margin, cost of capital, etc) and the impact projects have on them 2. Investment (project) appraisal financial considerations 3. Investment (project) appraisal - non-financial considerations a firm uses a broad spectrum of good financial valuation tools to select projects, depending on the type of projects projects have good business cases, supported by technical and marketing studies / use of the Balanced Scorecard (or a similar) for portfolio selection / good resourcing consideration, including change capacity * and critical chain at portfolio level 4. Risk good risk impact and probability assessment / management at portfolio level 5. Project portfolio / prioritisation the contribution to shareholder value is the main criterion for project prioritisation and inclusion of a project in the active portfolio 6. Project structures and systems formal project structures and systems, including good reporting which provide comparative information on projects, allowing informed decisions before changes to project portfolio and capital budget are made 7. Stakeholders / complexity / integration there is a good level of project work integration among units, lines and functions / complexity is proactively managed 8. Innovation / IT innovation is championed by the business. IT is well managed and leveraged to support business innovation, rather than just administer technology stability and maintenance 9. Productivity / performance the project portfolio yield is measured using a diverse set of measures including value measures and actively managed 10. Continual basis / uncertainty / flexibility changing dominant investors' expectations influence the project portfolio, which is regularly reviewed / a rolling budget is used 6

7 Survey Well over 600 people were contacted in more than 300 of firms. Overall response rate: 9%. 59 questionnaires were returned complete (in line with expectations) Most of the respondents worked for large European financial firms which operate globally they were from all the main organisational functions Note a small number of organisations contacted were non-financial firms (8%) from Fortune s Most Admired Companies list, used as a benchmark for the financials Projects in Financial Services don t appear to be selected and managed in a way that maximises SV 7

8 Respondents Role (All) Corporate position (All) Sector (All) Head Office (All) Geographical market (All) Size (All) 45 Count of Respondent ID Function IT (blank) Sales / Trading Research / Advisory Other Operations (Middle / Back Office) Operational Risk HR General Management Finance / Accounting 5 0 Large Cap Basket (financial) Mid & Small Cap Basket (financial) Basket Most Admired Basket (nonfinancial) 8

9 Respondents (cont.) Function (All) Corporate position (All) Sector (All) Head Office (All) Geographical market (All) Size (All) 45 Count of Respondent ID Role (blank) Senior management Project management Professional Other Line management Board member Large Cap Basket (financial) Mid & Small Cap Basket (financial) Basket Most Admired Basket (nonfinancial) 9

10 Respondents (cont.) Function (All) Role (All) Sector (All) Head Office (All) Geographical market (All) Size (All) 45 Count of Respondent ID Corporate position Corporate/cross unit Business unit Business line Large Cap Basket (financial) Mid & Small Cap Basket (financial) Basket Most Admired Basket (nonfinancial) 10

11 Respondents (cont.) Function (All) Role (All) Corporate position (All) Head Office (All) Geographical market (All) Size (All) 45 Count of Respondent ID Sector Universal banking Other Investment banking Insurance Commercial banking Large Cap Basket (financial) Mid & Small Cap Basket (financial) Basket Most Admired Basket (nonfinancial) 11

12 Respondents (cont.) Function (All) Role (All) Corporate position (All) Sector (All) Geographical market (All) Size (All) 45 Count of Respondent ID Head Office (blank) Western Europe Other North America Eastern Europe Central / South America Australasia Large Cap Basket (financial) Mid & Small Cap Basket (financial) Basket Most Admired Basket (nonfinancial) 12

13 Respondents (cont.) Function (All) Role (All) Corporate position (All) Sector (All) Head Office (All) Size (All) 45 Count of Respondent ID Geographical market Other Global Europe, Middle East & Africa Asia Pacific Americas Large Cap Basket (financial) Mid & Small Cap Basket (financial) Basket Most Admired Basket (nonfinancial) 13

14 Analysis by Area (overall scores) Large Cap Basket (financial) Mid & Small Cap Basket (financial) Most Admired Basket (non-financial) 14

15 Analysis by Area (cont.) Shareholder Value (SV) drivers Continual basis / uncertainty / Investment (project) appraisal flexibility financial considerations Productivity / performance Investment (project) appraisal - non-financial considerations Innovation / IT Risk Stakeholders / complexity / integration Project portfolio / prioritisation Project structures and systems Large Cap Basket (financial) Mid & Small Cap Basket (financial) Most Admired Basket (non-financial) 15

16 Recommendation 1 investment appraisal (financials) The business case should either state the cost of capital assumptions specific to the project or use a risk-adjusted NPV model There should be a standard model across the organisation for NPV calculations, to ensure consistency and fair assessments of competing projects The NPV needs to be revised on a regular basis to take into account changes in the markets and confirm the business case is still viable 16

17 Recommendation 2 project portfolio/ prioritisation At strategic level, mgmt should listen to the market to understand what it considers the drivers of shareholder value creation for the firm (in the long run) test the impact of different project portfolios with the help of models simulating the SV generated in different scenarios At operational level, mgmt should decide, on a regular basis, which projects should be in and out of the portfolio, thru project portfolio reviews form a Project Portfolio Committee, composed by functional heads and a board member, that will attend the reviews use best practice project portfolio management tools to review and manage the portfolio 17

18 SVA Model COMPETITIVE ADVANTAGE PERIOD Year Beyond Sales Growth Rate (SGR) 5% 5% 5% 5% 5% 0% EBITDA Margin 10% 10% 10% 10% 10% 10% Cash Tax Rate (CTR) 30% 30% 30% 30% 30% 30% IFCI 10% 10% 10% 10% 10% 0% WCI 10% 10% 10% 10% 10% 0% Cost of Capital 10% 10% 10% 10% 10% 10% m m m m m m m Depreciation RFCI Sales Receipts EBITDA less Cash Tax Operating Cash Flow less RFCI less IFCI less WCI Free Cash Flow Discount factor Present Value (Free Cash Flow) Cumulative Present Value (Cum FCF) Present Value of Residual Value 104 Business Value 145 add Marketable Securities 0 Corporate Value 145 less Market Value of Debt 20 Strategic Value 125 Number of Shares (m) 100 Strategic Value per Share 1.25 Based on Mills' Model (Mills, 1999); figures are illustrative Legend: EBITDA = Earnings before Interest and Tax, Depreciation and Amortisation RFCI = Replacement Fixed Capital Investment [to enable intended sales growth] IFCI = Incremental Fixed Capital investment [to enable intended sales growth] WCI = Working Capital Investment [to enable intended sales growth] 18

19 Project Portfolio Management Investment name (ranked by Risk-adjusted NPV) Project E (Product E) Project A (Product A) Project C (Product C) Project D (Product D) Project F (Product F) Project B (Product B) NPV Risk adjustment Riskadjusted NPV Story (case non financial considerations / strategic alignment) PPC Call A B A*B Mgmt Investors $ $175 good great Fund Comments $ $144 great great Fund on track, no assumptions changes $ $126 good good Fund on track, no assumptions changes $ $120 good good Fund INVESTMENT CUT-OFF (Financial / Human Resource Constrains) $ $120 good okay Reject Good financials, but story not good enough compared to Project D. Both fit the strategy, but D better meets investor expectations $ $20 okay okay Kill Major assumptions changes, due to changes in the market (sentiment) Legend: PPC call = Project Portfolio Committee decision at last (quarterly) PPC meeting Figures are illustrative 19

20 Project Portfolio Management (additional) Alternative perspectives: payback (period); capital already invested & achievements (v plan), capital requirements to completion (v plan) Real options: high risk-high reward initiatives that may be ruled out by low riskadjusted NPV Cost and risk projects: respectively impact E(Ct) and αt in the Walters formula: NPV ( firm) = n E( Rt) E( Ct) α t t= 1 (1 + It + t) Where: NPV(firm) = the risk-adjusted discounted present value of a firm s after-tax earnings E(Rt) = the expected future revenues of the firm E(Ct) = expected future operating costs, including charges to earnings for restructurings, loss provisions and taxes The net expected returns in the numerator are then discounted to the present using It = risk-free rate and αt = a composite risk adjustment which captures the variance of expected net future returns resulting from credit risk, market risk, operational risk, and reputation risk, and the correlations between such risks associated with the firm s various activities 20

21 Recommendation 3 productivity/ performance Regular reviews of NPV assumptions, project progress Good financial and non-financial metrics DB of projects with current and historical project data: Projects contribution, current & over time: new v old (ops) Repeat project mistakes avoid! 21

22 The Great Recession Source: Interactive Data 22

23 Q&A Thank you. 23